Trading Punches: Microsoft v EU Commission

The IT industry and others are now waiting for the outcome of Microsoft’s appeal against the European Commission’s decision and €497 million fine for abuse of a dominant position.  As we anticipate the epilogue, the tension between the need to ensure effective competition on the one hand and protection for intellectual property rights on the other is once again brought into sharp relief.

Back in March 2004, the Commission decided that Microsoft had abused its dominant position by: (i) bundling Windows Media Player with its ubiquitous PC operating system; and (ii) refusing to supply interface information to its competitors in work group operating systems.  Microsoft claims, inter alia, that Windows Media Player is part of its operating system and therefore that there is no ‘bundling,’ and that its refusal to supply interface information is justified by the need to protect its intellectual property rights.  Both parties presented their case before the European Court of First Instance in a five-day hearing in April.  Pending the result of the appeal, the Commission’s decision continues to have important implications for the technology sector and for competition law enforcement in general.     

The 2004 EU ‘Microsoft’ Decision

In response to a complaint by Sun Microsystems Inc, the Commission began a five-year investigation of alleged abusive behaviour on the part of Microsoft in connection with its ‘Windows 2000’ PC work group server operating systems and the integration of Microsoft’s ‘Windows Media Player’ software into its PC operating systems. 

In March 2004, the Commission decided that Microsoft had refused to supply indispensable interoperability information relating to its operating system to rival work group server operating system producers, thereby restricting the ability of rivals to compete.  The Commission also decided that Microsoft had abusively made the availability of Windows PC operating systems conditional on the acquisition of Windows Media Player, ie it had ‘bundled’ the two products, thereby denying consumers the choice of using other media player software. 

As Microsoft had a near monopoly in the market for PC operating systems, the Commission held such conduct to be an abuse of Microsoft’s dominant position, contrary to Article 82 of the EU Treaty.

In reaching its conclusion regarding Microsoft’s refusal to supply interface information, the Commission relied on the European Court of Justice decisions in Commercial Solvents,[1] Telemarketing,[2] Magill,[3] and Bronner.[4]  The Commission found that:

·                    refusal by a dominant firm to supply an input product to a customer who requires such products to produce derivatives which compete with the dominant firm’s product could constitute an abuse contrary to Article 82 EC

·                    refusal by a dominant firm to supply services which are indispensable for the activities of other undertakings on another market could also constitute an abuse

·                    a dominant company’s refusal to license intellectual property rights could, in exceptional circumstances, constitute an abusive exercise of those rights.

In Magill, the ECJ ruled that a dominant undertaking could be ordered to license its intellectual property in the following ‘exceptional circumstances’: (i) the intellectual property must be ‘indispensable’ for rivals to compete; (ii) the potential licensee must intend to offer a ‘new product’ for which there is consumer demand; (iii) the refusal to grant a licence must eliminate competition in a secondary market; and (iv) the refusal must not be justified by objective considerations.

The Commission found that, as a result of Microsoft’s behaviour, consumers were forced to favour Microsoft’s server products over the products of rivals such as Novell, Linux and Unix.  Such conduct threatened to eliminate competition in the market for work group server operating systems. 

With a view to remedying Microsoft’s refusal to supply interface information, the Commission ordered Microsoft to disclose to its rivals specifications for all Windows Work Group Server Protocols.  The disclosure applied prospectively to future updates and versions of the product.  Microsoft’s source code was, however, excluded from the order.[5]

In order to remedy the ‘bundling’ abuse, Microsoft was ordered to offer a version of its Windows PC Operating System which did not incorporate Windows Media Player.  This led to the production of Windows XP-N.  The Commission’s Order allowed Microsoft to continue to offer a bundled version of Windows Client PC Operating System and Windows Media Player. 

Effects and Reactions

The Commission’s decision has polarised parts of the IT industry.  On the one hand, Microsoft supporters believe that consumers are best served by Microsoft’s business model and new products.  Microsoft and others also consider that intellectual property should continue to be protected in order to foster innovation.  On the other hand, open source advocates believe that Microsoft’s policies and practices foreclose rivals, stifle innovation and restrict consumer choice. 

Microsoft claims that, in any event, the disclosure order is too wide, requiring it to supply rivals with valuable intellectual property, thereby enabling rivals to access and recreate every new technology.  According to Microsoft, this would enable competitors to clone its products, and this goes beyond what is required for interoperability. 

Two years after the Decision, the Commission maintains that Microsoft has not complied with the interoperability order.  In July this year, the Commission imposed additional fines on Microsoft of €1.5 million per day, emphasising its determination to enforce the decision.  Microsoft intends to appeal this additional fine, on the basis that the Commission’s lack of clarity made it impossible for Microsoft to comply with the order earlier.  On 31 July, Microsoft submitted its final set of documents, which are now being analysed by Commission experts.  If the Commission is not satisfied with these documents, the daily fines could potentially rise to €3 million. 

As regards Microsoft’s ‘bundling’ abuse, competitors claim that the company has not eradicated bundling from its business plan and will continue to bundle new anti-virus and digital rights management software into Vista, the next version of Windows.  

In June 2004, Microsoft applied to the CFI for the annulment of the Commission decision and for interim suspension of the remedies.  Judge Bo Vesterdorf rejected the application for interim relief, deciding that Microsoft would not suffer irreparable harm from the remedies, even if Microsoft’s substantive application for annulment were successful.  Both Microsoft and the Commission presented their cases to the CFI at an appeal hearing in April.[6]  

By the time the appeal was heard, Microsoft had successfully negotiated settlements with all of the complainants involved in the Commission’s investigation, including Sun Microsystems, JBoss and Real Networks.  Whilst a number of these deals may be interpreted as Microsoft ‘paying off’ rivals, the company’s settlement with open source software provider JBoss may have more positive implications for the industry.  The ‘technology engagement’ between the two companies aims to improve interoperability between their products,[7] allow collaboration on connectivity and develop a JBoss Management Pack for the Microsoft Operations management platform.  In the past, Microsoft has disagreed with the open source industry about the terms under which its intellectual property could be licensed.[8]  Microsoft continues to object to releasing its source code under a General Public Licence.  The JBoss settlement indicates that Microsoft is prepared to work with the open source industry in circumstances where its intellectual property rights are not significantly impacted.     

Interesting Aspects of the Oral Hearing

The complexities of Microsoft’s and the Commission’s arguments were highlighted during the appeal hearing in April. 

With regard to the supply of interface information, Microsoft argued that the criteria for compulsory licensing set out in Magill had not been met: (i) the relevant technology was not indispensable to achieve interoperability; (ii) the refusal to supply had not prevented the emergence of new products on a secondary market – as illustrated by the success of the Linux operating system, which did not require access to Microsoft protocols; (iii) the refusal to supply had not excluded competition on a secondary market, because no major player had ever been forced out of the server market; and (iv) in any event, Microsoft was justified in its refusal to license on the grounds, inter alia, that it was entitled to protect its intellectual property.

During the oral hearing, the judges repeatedly suggested that the Commission may have extended the criteria for compulsory licensing in its decision against Microsoft.  In response, the Commission argued that the Magill criteria were only an example of ‘exceptional circumstances’ and were not the only basis upon which compulsory licensing can be required.

Microsoft claimed that, in reality, different servers were already interoperable, and the majority of companies did not find interoperability to be a problem.  Another of Microsoft’s arguments was that the Commission wrongly denied that Microsoft could not rely on its intellectual property rights to justify its refusal to supply.    Microsoft also argued, inter alia, that the Order violated international law by forcing it to disclose trade secrets, copyrights and patents.[9] 

The Commission considered that trade secrets should not qualify for the same protection as copyrights and patents.[10]  The Commission also claimed that, in any event, the information did not qualify for intellectual property protection.  One of the judges disagreed, considering that interoperability information was valuable commercial information, resulting from years of development.  The CFI rejected the Commission’s assertion that copyright and patents could be ignored because Microsoft had not previously asserted them.  The CFI also appeared to object to the idea that a company could be forced to disclose trade secrets simply because such secrets strengthened a dominant position.           

In relation to bundling, Microsoft argued that the decision was based on a ‘speculative theory of foreclosure’ according to which, as a result of Microsoft’s future monopoly, all encoding would be exclusively in Windows Media formats.  Microsoft submitted that this theory was inconsistent with evidence that content providers continue to encode in multiple formats. 

Furthermore, Microsoft claimed that Windows and Media functionality were not two separate products but one composite product connected by commercial usage.  One of Microsoft’s lawyers in court noted that ‘customers have come to expect shoes to be sold with laces, even though laces are sold separately’.  The same applied to Windows and Media Player.

Finally, in addition to arguing that the unbundling remedy was disproportionate, Microsoft argued that the remedy had been unsuccessful, as demonstrated by the extremely low number of orders for Windows XP-N.  The Commission suggested that it could revise the remedy, possibly imposing price differentials to improve demand for the product.[11] 

The judges spent an extended period of time questioning the Commission about its conclusions on tying and foreclosure.  They suggested that the Commission did not understand the reality of the market place and that consumer demands were changing. The judges observed that Microsoft Word had obtained a market share of over 90% without the use of tying.  Accordingly, Windows Media Player’s popularity may have developed on the same basis, rather than as a result of tying.  The CFI may simply have been testing the strength of the Commission’s case by playing Devil’s Advocate.  The judges also expressed doubts that Windows Media Player was not a separate application, as argued by Microsoft. 

As we await the outcome of Microsoft’s appeal, the Commission is determined to enforce its original decision, which continues to have important implications for IT and other industries.

Implications of the Commission’s Decision and the Appeal

Microsoft’s successful business model has been based on leveraging its monopoly in PC operating systems into other markets by tying in peripheral functionality and other products.  The Commission’s decision has established that Microsoft’s use of this strategy with respect to its media player software is unlawful.  Microsoft appears to have taken the view that the Commission’s decision is limited to the facts of the case and, according to competitors, it shows no signs of altering its ‘leveraging’ business model with respect to other products and services. 

However, unless its appeal is successful, Microsoft’s business practices create legal risk.  A major reason why the Commission pursued this case was the need to establish a clear precedent for future cases.  The Commission felt that its remedies would offer more to consumers worldwide than a settlement with Microsoft.  The Commission is investigating other aspects of Microsoft’s activities as and when the company leverages its market power into various related markets, such as those in the digital media sector, software for the broadcasting of music over the Internet and digital rights management. 

Pending the result of the appeal, the decision is also likely to have implications for many other technology companies across the industry.  The bundling of functionality into software packages, which is commonplace, may now be illegal in markets where the bundler is dominant.  Also, the Commission has now set a precedent which allows it to enforce more vigorously the development of open systems under Article 82 EC.  Technology companies, including software companies, electronic publishers and service providers will therefore need to review their policies in relation to disclosure and bundling in light of the Microsoft decision.  Challenges to tying and non-disclosure/refusal to license are likely to increase as companies begin to take advantage of the decision and use competition law as a ‘sword’ in order to help fulfil their commercial objectives.

 

Davina Garrod is a Partner in the EU/UK Competition Group at McDermott Will & Emery UK LLP: dgarrod@europe.mwe.com.

Lara Kuehl is a Trainee Solicitor in that Group: lkuehl@europe.mwe.com.